Description

XLP, the consumer staples iShare, was written up in 2006 by tbzeej825. What stuck in my mind the most about that writeup, and probably the reason I'm still holding those XLP shares, was the simple idea that the price of the index had stayed pretty much flat over the previous 6 years, yet the dividend had almost doubled. So, in the year 2000, the etf paid 27 cents, in 2006 it paid 50 cents, yet the share price stayed the same (payout ratio stayed about the same, too). XLP now looks like it'll be paying 75 cents in 2010 which is almost triple the dividend from a decade ago, and the share price is still where it was at the beginning of the decade.

That being said, my XLP report is different than tbzeej825's. (1) I'm going to talk craziness about gold & inflation, and not so much about interest rates (2) I'm going to argue that p/e contraction we've experienced this decade is less relevant now because the dividend is a bigger part of the return, and (3) I'm going to look at the returns of various sectors over fivedecades. Tbzeej825's report is a great walk down memory lane and the areas covered by that writeup are important and still stand on their own (especially the observation about trough p/e ratios from 1994).

GOLD. So, despite my first paragraph, this idea is not really about chasing a 2 or 3% dividend (that's been increasing by 10% per year). The idea is that XLP is fundamentally superior inflation protection at this point in time because gold has already run up quite a bit, and its run may be over. Gold is shiny, easy to transport and completely free from the pesky constraints of cash flow analysis. It is impossible to ignore nowadays. Since the beginning of time gold has been the ultimate true currency, so once again investors have chosen it as their weapon of choice to defend their purchasing power. For the last decade it has worked.

"At the current rate of inflation, a loaf of bread will cost $2062 when you go to college," said my dad in the 1970's. Anecdotes like those fed inflation fears. Across the board increases in daily necessities drove the rally in gold to the $850/ounce peak. When people got scared they bought gold and the price went up. Unfortunately, it didn't stay up. So, the problem is, and always has been with these types of speculations, when do you sell?

XLP's value proposition as an inflation hedge over gold is that it is fairly priced now and it could do extremely well when/if the tide changes for gold (and we get actual inflation). You get inflation protection that actually makes sense and you don't have to worry about that tricky sell decision. Gold speculators are looking for a repeat of the 1970's gold rush and ignoring the 1980's. They forgot that most people got left holding the bag (of gold). If you own gold right now, you may have already seen the top. You won't know until it has dropped to $500 per ounce. In the 70's, when the fear finally subsided, gold didn't survive the aftermath. Consumer staples' prices stayed high. Beer moved up from 99 cents for a six pack to above $3/sixpack and has remained there ever since. There are no more coke machines selling soda for a dime. There are no more loaves of bread for a quarter. Nothing cushioned gold's fall to $300. Look at the government CPI data... Despite Volker's best efforts, prices on *stuff we use on a daily basis* stayed high but gold did not.

Year

CPI

$ gold

1968

36

42

1969

38

35

1970

40

37

1971

41

44

1972

43

65

1973

46

112

1974

52

187

1975

56

140

1976

58

135

1977

62

165

1978

68

226

1979

77

524

1980

86

850

<<--- gold peaked

1981

94

400

1982

98

448

1983

101

382

1984

105

308

1985

109

327

1986

111

391

1987

115

487

1988

121

410

1989

126

401

1990

134

353

But most importantly: Consumer staples stocks delivered a decade of excellent returns following gold's fall from grace. Why bother with gold now? You might miss the last $100 of the gold rally, or the last $1000, or the last $2000, whatever... but the rally hasn't even begun with XLP and it pays you to sit and wait for it to begin.

FIVE DECADES OF SECTOR RETURNS

Sector

1960s

1970s

1980s

1990s

2000s

Consumer discretionary

106%

24%

414%

242%

32%

Consumer staples

160

6

552

258

-25

Energy

107

295

135

67

206

Financials

80

19

169

242

-16

Health care

165

1

355

308

8

Industrials

53

39

297

147

11

Information technology

368

-13

171

1,140

-56

Materials

13

78

243

82

63

Telecom

--

--

--

218

-58

Utilities

30

43

137

60

45

*This data is from consumerreports.org, October 2008, it doesn't line up perfectly with the return for XLP, and I'm not sure how they adjust it, but it appears to be good enough for general sector analysis.

Observe the relationship between consumer staples and energy stocks in the 1970's. Look how the investment returns for consumer staples rebounded in the 80's. That relationship *could* repeat itself this decade. The relationship is logical. Investors chased gold, commodities, oil, etc. They over-invested because the returns were good. Then there was over-capacity (shale gas, China, etc.) and the returns turned south. Lately investors have ignored consumer staples (p/e contraction). I can't easily make this same argument for the other sectors because of their nature. IT & Telecom technologies move so fast and financials didn't rebound so much during the 80's so it's hard to tell with them.

P/E contraction. Trying to figure out when the P/E ratio will stop contracting is tricky but today's price is easily justified using a dividend discount model with conservative inputs. For most of this decade, the results of this model would not justify the current share price. The price of the index assumed a growth rate higher than the cost of capital (and to be fair, the dividends did actually grow at over 10%/year). The dividend discount model is very sensitive to inputs, but to show you how cheap XLP has gotten, I put in some basic numbers that I applied universally to the entire decade: 4% growth in dividends, 5% market risk premium, .57 Beta (actual), 3% risk free rate. At the beginning of the decade, the model estimated a significantly lower value than the actual share price. Only recently has the model justified the share price. Now the results exceed the share price.

rolling

Actual

Date

DDM value

share price

3/19/2010

$ 35.15

26

12/18/2009

$ 38.95

26

6/19/2009

$ 35.83

23

3/18/2009

$ 32.81

20

12/30/2008

$ 34.01

24

9/30/2008

$ 31.25

28

6/20/2008

$ 29.43

28

3/20/2008

$ 32.03

27

12/21/2007

$ 31.15

29

9/21/2007

$ 30.32

27

6/15/2007

$ 28.96

28

3/16/2007

$ 26.78

26

12/15/2006

$ 26.62

26

9/15/2006

$ 26.05

26

6/16/2006

$ 25.32

24

3/17/2006

$ 24.54

24

12/16/2005

$ 22.98

24

9/16/2005

$ 21.68

23

6/17/2005

$ 20.59

23

3/18/2005

$ 19.29

23

12/17/2004

$ 18.56

22

9/17/2004

$ 18.36

22

6/18/2004

$ 17.21

23

3/19/2004

$ 17.47

23

12/19/2003

$ 18.67

21

9/19/2003

$ 19.40

20

6/20/2003

$ 22.57

20

3/21/2003

$ 21.53

19

12/20/2002

$ 19.97

20

9/20/2002

$ 18.56

21

6/21/2002

$ 15.91

25

3/15/2002

$ 15.91

26

9/21/2001

$ 15.29

25

6/15/2001

$ 15.91

26

You can use whatever inputs you want, and this relationship holds. The key thing is that today's share price assumes the smallest ongoing increase in dividends of the decade (using above inputs, the $26 price only assumes a 3.2% growth rate of dividends vs 10% actual growth in dividends). The costs of capital, theoretical risk free rate, whatever you use now, are likely all lower now than they were at the beginning of the decade.

To put that into perspective, looking at analysts' estimates across all 41 positions by their weight in the index and maintaining the current payout ratio, you will get a 5% increase of dividends in 2010 and a 7% increase in 2011. So the 3.2% growth in dividends the share price assumes is conservative (remember how sensitive this model is to growth assumptions, just a 1% change in growth estimates effects the fair price by a large amount).

In the last decade we saw a whirlwind of inflation in commodity prices, followed by mild consumer price deflation, yet the companies in this index consistently increased sales, increased earnings, increased dividends and decreased the amount of shares outstanding.

Top 10 companies (67% of index), sales/share:

decade ago

previous writeup

actual

2000 sales/share

2006 sales/share

2009 sales/share

PG

15.21

22.33

26.77

WMT

37.48

74.61

105.59

KO

7.01

10.26

13.39

CVS

25.69

53.40

68.85

PEP

12.78

21.31

27.75

CL

15.66

23.75

30.68

WAG

21.05

46.93

63.98

PM

22.90

34.35

KFT

20.24

27.32

MO

9.00

11.40

Top 10 companies, EPS:

decade ago

previous writeup

actual

est

est

2000 EPS

2006 EPS

2009 EPS

2010 EPS

2011 EPS

PG

1.30

2.64

4.49

4.12

4.01

WMT

1.21

2.68

3.40

4.00

4.38

KO

0.88

2.16

2.95

3.44

3.74

CVS

0.94

1.65

2.58

2.80

3.10

PEP

1.45

3.41

3.81

4.15

4.64

CL

1.81

2.46

4.53

4.87

5.33

WAG

0.77

1.73

2.03

2.22

2.65

PM

2.91

3.25

3.80

4.19

KFT

1.71

2.04

2.03

2.32

MO

1.51

1.55

1.87

2.00

Over the last couple of years, the top 10 companies have been buying back shares at a steady clip, (such that there are .4% less shares every quarter). Overall, the companies in the index have been canceling shares at a rate of .25% per quarter over the last 8 quarters.

2010 analyst estimates for the top 10 holdings (67% of index) come in such that they trade at 13.6x earnings vs. 17x earnings in 2006 and 39x earnings from 2000.

You see how the EPS have increased, the payout ratio has remained stable:

The average payout ratio for all 41 stocks in the index over the last 7 years is 45%, the payout ratio for the most recent year was 45%. The average total liabilities to total assets has remained the same at 65% for the last 7 years. Long term debt to total capital for the index has increased modestly to 52% from an average of 43% over the last 7 years.

Catalyst

investors rotate into less economically sensitive investments

xlp catches up for its lost decade

dividends increase faster than market assumes

sort by

Description

XLP, the consumer staples iShare, was written up in 2006 by tbzeej825. What stuck in my mind the most about that writeup, and probably the reason I'm still holding those XLP shares, was the simple idea that the price of the index had stayed pretty much flat over the previous 6 years, yet the dividend had almost doubled. So, in the year 2000, the etf paid 27 cents, in 2006 it paid 50 cents, yet the share price stayed the same (payout ratio stayed about the same, too). XLP now looks like it'll be paying 75 cents in 2010 which is almost triple the dividend from a decade ago, and the share price is still where it was at the beginning of the decade.

That being said, my XLP report is different than tbzeej825's. (1) I'm going to talk craziness about gold & inflation, and not so much about interest rates (2) I'm going to argue that p/e contraction we've experienced this decade is less relevant now because the dividend is a bigger part of the return, and (3) I'm going to look at the returns of various sectors over fivedecades. Tbzeej825's report is a great walk down memory lane and the areas covered by that writeup are important and still stand on their own (especially the observation about trough p/e ratios from 1994).

GOLD. So, despite my first paragraph, this idea is not really about chasing a 2 or 3% dividend (that's been increasing by 10% per year). The idea is that XLP is fundamentally superior inflation protection at this point in time because gold has already run up quite a bit, and its run may be over. Gold is shiny, easy to transport and completely free from the pesky constraints of cash flow analysis. It is impossible to ignore nowadays. Since the beginning of time gold has been the ultimate true currency, so once again investors have chosen it as their weapon of choice to defend their purchasing power. For the last decade it has worked.

"At the current rate of inflation, a loaf of bread will cost $2062 when you go to college," said my dad in the 1970's. Anecdotes like those fed inflation fears. Across the board increases in daily necessities drove the rally in gold to the $850/ounce peak. When people got scared they bought gold and the price went up. Unfortunately, it didn't stay up. So, the problem is, and always has been with these types of speculations, when do you sell?

XLP's value proposition as an inflation hedge over gold is that it is fairly priced now and it could do extremely well when/if the tide changes for gold (and we get actual inflation). You get inflation protection that actually makes sense and you don't have to worry about that tricky sell decision. Gold speculators are looking for a repeat of the 1970's gold rush and ignoring the 1980's. They forgot that most people got left holding the bag (of gold). If you own gold right now, you may have already seen the top. You won't know until it has dropped to $500 per ounce. In the 70's, when the fear finally subsided, gold didn't survive the aftermath. Consumer staples' prices stayed high. Beer moved up from 99 cents for a six pack to above $3/sixpack and has remained there ever since. There are no more coke machines selling soda for a dime. There are no more loaves of bread for a quarter. Nothing cushioned gold's fall to $300. Look at the government CPI data... Despite Volker's best efforts, prices on *stuff we use on a daily basis* stayed high but gold did not.

Year

CPI

$ gold

1968

36

42

1969

38

35

1970

40

37

1971

41

44

1972

43

65

1973

46

112

1974

52

187

1975

56

140

1976

58

135

1977

62

165

1978

68

226

1979

77

524

1980

86

850

<<--- gold peaked

1981

94

400

1982

98

448

1983

101

382

1984

105

308

1985

109

327

1986

111

391

1987

115

487

1988

121

410

1989

126

401

1990

134

353

But most importantly: Consumer staples stocks delivered a decade of excellent returns following gold's fall from grace. Why bother with gold now? You might miss the last $100 of the gold rally, or the last $1000, or the last $2000, whatever... but the rally hasn't even begun with XLP and it pays you to sit and wait for it to begin.

FIVE DECADES OF SECTOR RETURNS

Sector

1960s

1970s

1980s

1990s

2000s

Consumer discretionary

106%

24%

414%

242%

32%

Consumer staples

160

6

552

258

-25

Energy

107

295

135

67

206

Financials

80

19

169

242

-16

Health care

165

1

355

308

8

Industrials

53

39

297

147

11

Information technology

368

-13

171

1,140

-56

Materials

13

78

243

82

63

Telecom

--

--

--

218

-58

Utilities

30

43

137

60

45

*This data is from consumerreports.org, October 2008, it doesn't line up perfectly with the return for XLP, and I'm not sure how they adjust it, but it appears to be good enough for general sector analysis.

Observe the relationship between consumer staples and energy stocks in the 1970's. Look how the investment returns for consumer staples rebounded in the 80's. That relationship *could* repeat itself this decade. The relationship is logical. Investors chased gold, commodities, oil, etc. They over-invested because the returns were good. Then there was over-capacity (shale gas, China, etc.) and the returns turned south. Lately investors have ignored consumer staples (p/e contraction). I can't easily make this same argument for the other sectors because of their nature. IT & Telecom technologies move so fast and financials didn't rebound so much during the 80's so it's hard to tell with them.

P/E contraction. Trying to figure out when the P/E ratio will stop contracting is tricky but today's price is easily justified using a dividend discount model with conservative inputs. For most of this decade, the results of this model would not justify the current share price. The price of the index assumed a growth rate higher than the cost of capital (and to be fair, the dividends did actually grow at over 10%/year). The dividend discount model is very sensitive to inputs, but to show you how cheap XLP has gotten, I put in some basic numbers that I applied universally to the entire decade: 4% growth in dividends, 5% market risk premium, .57 Beta (actual), 3% risk free rate. At the beginning of the decade, the model estimated a significantly lower value than the actual share price. Only recently has the model justified the share price. Now the results exceed the share price.

rolling

Actual

Date

DDM value

share price

3/19/2010

$ 35.15

26

12/18/2009

$ 38.95

26

6/19/2009

$ 35.83

23

3/18/2009

$ 32.81

20

12/30/2008

$ 34.01

24

9/30/2008

$ 31.25

28

6/20/2008

$ 29.43

28

3/20/2008

$ 32.03

27

12/21/2007

$ 31.15

29

9/21/2007

$ 30.32

27

6/15/2007

$ 28.96

28

3/16/2007

$ 26.78

26

12/15/2006

$ 26.62

26

9/15/2006

$ 26.05

26

6/16/2006

$ 25.32

24

3/17/2006

$ 24.54

24

12/16/2005

$ 22.98

24

9/16/2005

$ 21.68

23

6/17/2005

$ 20.59

23

3/18/2005

$ 19.29

23

12/17/2004

$ 18.56

22

9/17/2004

$ 18.36

22

6/18/2004

$ 17.21

23

3/19/2004

$ 17.47

23

12/19/2003

$ 18.67

21

9/19/2003

$ 19.40

20

6/20/2003

$ 22.57

20

3/21/2003

$ 21.53

19

12/20/2002

$ 19.97

20

9/20/2002

$ 18.56

21

6/21/2002

$ 15.91

25

3/15/2002

$ 15.91

26

9/21/2001

$ 15.29

25

6/15/2001

$ 15.91

26

You can use whatever inputs you want, and this relationship holds. The key thing is that today's share price assumes the smallest ongoing increase in dividends of the decade (using above inputs, the $26 price only assumes a 3.2% growth rate of dividends vs 10% actual growth in dividends). The costs of capital, theoretical risk free rate, whatever you use now, are likely all lower now than they were at the beginning of the decade.

To put that into perspective, looking at analysts' estimates across all 41 positions by their weight in the index and maintaining the current payout ratio, you will get a 5% increase of dividends in 2010 and a 7% increase in 2011. So the 3.2% growth in dividends the share price assumes is conservative (remember how sensitive this model is to growth assumptions, just a 1% change in growth estimates effects the fair price by a large amount).

In the last decade we saw a whirlwind of inflation in commodity prices, followed by mild consumer price deflation, yet the companies in this index consistently increased sales, increased earnings, increased dividends and decreased the amount of shares outstanding.

Top 10 companies (67% of index), sales/share:

decade ago

previous writeup

actual

2000 sales/share

2006 sales/share

2009 sales/share

PG

15.21

22.33

26.77

WMT

37.48

74.61

105.59

KO

7.01

10.26

13.39

CVS

25.69

53.40

68.85

PEP

12.78

21.31

27.75

CL

15.66

23.75

30.68

WAG

21.05

46.93

63.98

PM

22.90

34.35

KFT

20.24

27.32

MO

9.00

11.40

Top 10 companies, EPS:

decade ago

previous writeup

actual

est

est

2000 EPS

2006 EPS

2009 EPS

2010 EPS

2011 EPS

PG

1.30

2.64

4.49

4.12

4.01

WMT

1.21

2.68

3.40

4.00

4.38

KO

0.88

2.16

2.95

3.44

3.74

CVS

0.94

1.65

2.58

2.80

3.10

PEP

1.45

3.41

3.81

4.15

4.64

CL

1.81

2.46

4.53

4.87

5.33

WAG

0.77

1.73

2.03

2.22

2.65

PM

2.91

3.25

3.80

4.19

KFT

1.71

2.04

2.03

2.32

MO

1.51

1.55

1.87

2.00

Over the last couple of years, the top 10 companies have been buying back shares at a steady clip, (such that there are .4% less shares every quarter). Overall, the companies in the index have been canceling shares at a rate of .25% per quarter over the last 8 quarters.

2010 analyst estimates for the top 10 holdings (67% of index) come in such that they trade at 13.6x earnings vs. 17x earnings in 2006 and 39x earnings from 2000.

You see how the EPS have increased, the payout ratio has remained stable:

The average payout ratio for all 41 stocks in the index over the last 7 years is 45%, the payout ratio for the most recent year was 45%. The average total liabilities to total assets has remained the same at 65% for the last 7 years. Long term debt to total capital for the index has increased modestly to 52% from an average of 43% over the last 7 years.

Catalyst

investors rotate into less economically sensitive investments

xlp catches up for its lost decade

dividends increase faster than market assumes

Messages

Subject

comments

Entry

06/04/2010 03:49 PM

Member

skyhawk887

I thought this was a very good, thought-provoking write-up.

I believe that we are in store for a Japanese style deflation scenario. The alternative is a default of the US federal deficit which will probably result in a Titanic Depression. Why?

There is no way our government can afford to roll over its huge debt and long-term structural deficits (thanks to Medicare and retiring baby-boomers) at higher interest rates. The vast majority of the debt is short term in nature (i.e. less than 2 years) and many of the obligations have inflation adjustments. If the US government was forced to refinance at rates even only near 5-6%, its interest costs would surge, and a debt/confidence/default crisis would ensue.

Subject

Still way way way better than GOLD!

Entry

09/26/2012 02:02 PM

Member

surf1680

I'm so proud of myself for not chiming in on the gold thread.

----------------------------------

XLP is timeless. Like GLD, the fancy new trading vehicle etf, XLP is also a relatively new trading vehicle. However, the assets behind the trading vehilcle are timeless. People have been selling crap that people need to other people since the beginning of time. Even before there was gold people were trying to sell basic necessities like the basic necessities that XLP sells to this day.

Using the same dividend discount model I used 2 years ago, XLP is now worth $49.61 per share. Cheap!

XLP recently paid a $.255 per share dividend. In the last decade XLP increased dividend by a factor of 3 yet the share price is up only 70%.

After gold peaked in 1980, consumer staples kept going. They had a heckuva decade despite Paul Voelker's best efforts to get a grip on inflation.

Consumer staples didn't go down as much as gold went down during the recent financial crisis.

Consumer staples sometimes go up when other stocks go down, lowering the volatility of your portfolio.

When they shyt really hits the fan and the dollar becomes worthless Walmart will accept whatever the prevailing currency, dog turds, gold coins - they don't care - they take the money du jour and redistribute it to their shareholders.

XLP outperformed GLD last year. XLP tied for the last 2 years including dividends.

XLP doesn't weigh anything so it's not as good as dog turds but still good for the cashflow.